Free Falling: Market Turbulence

The market has continued its run of increased volatility this week and therefore makes the subject featured on Monday's episode of Market Measures especially interesting.

With the S&P 500 index down at one point over 100 points from its closing price on August 21, 2015, Monday of this week was an especially eye-popping day of trading.

On a recent blog post, we discussed the fact that there had been a considerable drought since the market last suffered a 10% correction and after all that build-up market participants seem to have decided they should play catch-up in a couple days.

By the close of trading on Monday, the market had officially dropped roughly 11% from its peak in early summer.

Even more intriguing was the wide range in which equity markets traded on Monday and then again on Tuesday. While the S&P index opened up over 100 points down on Monday morning, it rallied back over 80 points intraday before ultimately closing back near the lows.

Traders were in for a similar ride on Tuesday when markets spiked at the open on news that the People's Bank of China (PBOC) had cut interest rates before ultimately tailing back down and closing lower than Monday. That equated to another 80+ point swing in the S&P before the day was out.

Taking the bull by horns (pun intended), Tom Sosnoff and Tony Battista focused on this incredible market turbulence during Monday's episode of Market Measures in order to add broader context to the wide-ranging action on Wall Street.

In this show, Tom and Tony quickly point out how dramatic moves like those referenced above in the S&P 500 have become more rare over the last couple years. They referenced tastytrade research on the subject illustrating quite clearly that since the start of 2012 these moves had decreased significantly.

The frequency of such moves over the last six years is illustrated in the graphic below, while the tendency for implied volatility to increase during such moves is depicted immediately after:

The point that Tom and Tony are building on is the fact that market turbulence can in fact be viewed as an opportunity to lock in more attractive trading levels at a time when many traders might be paralyzed by fear or confusion.

The hosts of Market Measures emphasize this point by introducing further research conducted at tastytrade that demonstrates during times of increased volatility the market often ultimately climbs higher. For short premium portfolios, a melt up market is in fact just what the doctor ordered.

This research is shown below:

Even more interesting is the fact that alongside this environment of implied volatility, we of course also find higher premiums and therefore tastier opportunity than would have been seen without the market turbulence.

The slides below, also from Monday's episode, show how much the average premium goes up on options with a 16% chance of finishing in the money during times of market turbulence. Additionally, we see how exaggerated market activity allows traders to sell premium on strikes that are even further away from the current market price of the underlying.

The takeaways from such market conditions, as discussed by Tom and Tony in more detail on the show, aren't that difficult to ascertain:

Options are priced up during times of high volatility, and in turn as a response to large down moves. This presents an opportunity to sell premium.

When volatility rises, we're able to sell options further away (in terms of strikes) for higher credits.

On average, the market recovered losses from selloffs over the next 53 days, with options accordingly dropping in price as conditions normalize.

With such dramatic action in the markets over the last several days, we encourage you to watch the entire episode of Market Measures devoted to market turbulence.

Similarly, we encourage you to follow the tastytrade website closely during this time to take advantage of other tasty programming relevant to current market events.

We greatly appreciate you being a part of the tastytrade community and would highly value any questions or suggestions you could impart in the comments section below.

New episodes of Market Measures can be accessed by following this link.

Earning a certain average profit per month by selling premium is something of interest to many investors and traders. Until now, no one knew how much extrinsic premium needed to be sold to generate a targeted average monthly profit. We’re about to change that.

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer.

Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardize Options.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.